Can I open Solo-401k even with employees using restrictions?

[drdds]

Hello friends,

I have a few questions the answers to which would help me decide what to do about my existing SEP-IRA and possible backdoor Roth.

I have part-time employees with employment duration under 1000 hours last year plus maximum income per year of under $5000.

1) Using the available employee service and pay requirements, am I allowed to open a Solo-401k?

2) If answer above is no, then I think that concludes the matter. And the other questions may be ignored.

However, if answer is yes, can I open it with $0 and not contribute to it at all? Do I still have to make contributions for employees even if I don't contribute at all now or in the future?

3) Is a rollover from a SEP-IRA to the Solo-401k considered an employer contribution that must be matched for the employees as well?

Thanks for any information. I am looking for ways to get rid of my SEP-IRA and Traditional IRA so that I can do backdoor Roth now and in the future.

[spiritrider]

1) You may adopt and operate a one-participant 401k plan if there are no eligible employees other than owner(s) and optionally their spouse(s).

The IRS allows you to restrict employee participation eligibility to those employees >= 21 and one year of service >= 1,000 hours/year.

2) No you do not necessarily need to make contributions in any given year, but it validates the purpose of the one-participant 401k.

Since you can't have eligible employees in a one-participant 401k, there is no participant to make contributions to. If you have eligible employees, you have to amend or terminate the one-participant 401k plan.

3) A rollover contribution is just that a rollover. It has nothing to do with employee or employer contributions. Which as I said above is irrelevant to any ineligible employees.

Either you qualify for a one-participant 401k plan or not.

[litovskyassetmanagement]

drdds wrote:

Hello friends,

I have a few questions the answers to which would help me decide what to do about my existing SEP-IRA and possible backdoor Roth.

I have part-time employees with employment duration under 1000 hours last year plus maximum income per year of under $5000.

1) Using the available employee service and pay requirements, am I allowed to open a Solo-401k?

2) If answer above is no, then I think that concludes the matter. And the other questions may be ignored.

However, if answer is yes, can I open it with $0 and not contribute to it at all? Do I still have to make contributions for employees even if I don’t contribute at all now or in the future?

3) Is a rollover from a SEP-IRA to the Solo-401k considered an employer contribution that must be matched for the employees as well?

Thanks for any information. I am looking for ways to get rid of my SEP-IRA and Traditional IRA so that I can do backdoor Roth now and in the future.

Click to expand...

I would be very careful opening a solo 401k if you have employees that can potentially become eligible. Some TPAs say that you should not do this because you don't have provisions in the solo 401k plan to handle the employee that becomes eligible. As soon as one employee becomes eligible, you would then need to scramble to set up a 401k plan and ditch your solo 401k plan, so that can be a problem. Thus I would not recommend doing a solo 401k.  You can do the SEP until your staff becomes eligible to contribute to that, and after that I would just set up a 401k with a record-keeper/TPA.  Maybe not the answer you were looking for, but it is erring on the side of caution.

 

[litovskyassetmanagement]

This is what Vanguard says regarding solo 401k eligibility:

Participants: "Sole proprietors or partners who have no common-law employees."

Note that this does not say 'no common law employees who work less than 1000 hours'.  So I believe you are 100% ineligible for a solo 401k.

[spiritrider]

Kon, this is not a generic limitation of one-participant 401k plans.

Vanguard's Individual 401k plan does not allow the election of employee eligibility restrictions in their adoption agreement. This is relatively unique and one of the reasons I do not recommend their plan. They also do not allow rollover contributions or their Admiral Shares.

However, this is not true of many other one-participant 401k plans. Fidelity, Schwab, TD Ameritrade, ETrade, etc... allow the election of employee eligibility restrictions in their adoption agreements/plans.

[litovskyassetmanagement]

spiritrider wrote:

Kon, this is not a generic limitation of one-participant 401k plans.

Vanguard’s Individual 401k plan does not allow the election of employee eligibility restrictions in their adoption agreement. This is relatively unique and one of the reasons I do not recommend their plan. They also do not allow rollover contributions or their Admiral Shares.

However, this is not true of many other one-participant 401k plans. Fidelity, Schwab, TD Ameritrade, ETrade, etc… allow the election of employee eligibility restrictions in their adoption agreements/plans.

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This is what Fidelity says:

Eligibility	Self-employed individuals and owner-only businesses and partnerships are eligible. Owners’ spouses may also participate.

I pretty much guarantee that there is no solo 401k that allows ANY non-spouse and non partner employees.  The eligibility rules are meant to apply to key employees/owners/partners, etc., not to W2 non-spouse/non-partner employees. The reason for that is exactly the fact that solo 401k is not meant to be a plan when you have any W2 employees.  You would be fine with 1099 contractors.  So yes, other plan docs might have more meat in them, but they are still not designed to apply to common law employees who are getting a W2. This is why if you already have employees I would try to run a SEP for as long as possible, and then switch to a 401k with a record-keeper/TPA, especially if you have a traditional type of business such as a medical or a dental practice that is a startup, so that over time as one grows the new plan would accommodate this. Or do a SIMPLE for a couple of years until someone becomes eligible, and then switch to a 401k the following year.  Anything but doing a solo 401k.

 

[spiritrider]

You are incorrect.

Th IRC 410a and IRS regulations apply to all 401k plans and allow the election of specific employee eligibility restrictions for all employees of all 401k plans including one-participant 401k plans.

26 U.S. Code § 410 - Minimum participation standards, (a) Participation

(1) Minimum age and service conditions
(A) General rule A trust shall not constitute a qualified trust under section 401(a) if the plan of which it is a part requires, as a condition of participation in the plan, that an employee complete a period of service with the employer or employers maintaining the plan extending beyond the later of the following dates—
(i) the date on which the employee attains the age of 21; or
(ii) the date on which he completes 1 year of service.

(3) Definition of year of service
(A) General rule For purposes of this subsection, the term “year of service” means a 12-month period during which the employee has not less than 1,000 hours of service.

More specifically see Fildelity's Self-Employed 401(k) Adoption Agreement  Refer to Section 3 COVERAGE

Also, see Schwab's Individual 401(k) Plan Adoption Agreement  Refer to Section Two. Eligibility.

To the best of my knowledge Vanguard is the only major provider using Ascensus plan documents to not support employee eligibility restrictions in their one-participant 401k adoption agreement. All the others allow these elections; Schwab, TD Ameritrade, ETrade, T. Rowe Price, etc...

And, I am not aware of any mainstream one-participant 401k provider other than Vanguard who does not support the elections. Since independent TPAs are all about flexibility, I would expect that most of them also allow the elections.

[litovskyassetmanagement]

Fidelity is very clear that you should not have non-partner/non-spouse employees, and so is Vanguard, I haven't checked others, but I'm sure that's the case as well. That's what makes it a 'solo' 401k.  The employees they are talking about are spouses and/or partners if they are getting a W2.  Vanguard allows spouses and partners as well. I think the confusion is that the plan document has all of the right language and the adoption agreement has severe limitations in place (on purpose).  Vangard's plan doc is just like any other 401k plan doc.  However, their adoption agreement is extremely limited.  So yes, other adoption agreements might have a little more or a little less, still does not change the fact that a solo 401k should only be adopted when you have only spouse employees and/or partners.

[spiritrider]

Kon Litovsky wrote:

Fidelity is very clear that you should not have non-partner/non-spouse employees, and so is Vanguard, I haven’t checked others, but I’m sure that’s the case as well. That’s what makes it a ‘solo’ 401k.  The employees they are talking about are spouses and/or partners if they are getting a W2.

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Sorry Kon, why can't you just admit you are plain wrong on this.

Fidelity is very clear that you can not have non-owner/non-spouse participants. They are very clear that you can restrict employee eligibility through their adoption agreement fully in compliance with the IRC and IRS regulations. Did you even bother to actually read the adoption agreements in the links I provided. If you had you would see they specifically allow such restrictions. Clearly they are talking about employees other than spouses, because that would be totally unnecessary.

This has been verified over the years with extremely knowledgeable and experienced TPAs. If all you are doing is talking to CSR's you are getting incorrect information. I and dozens others I know have had excludable employees for up to a decade or more. Someone even has had a plan audit in that time (trigger unrelated to eligible employees). On this issue all they were required to provide was employment and payroll records to verify no eligible employees were improperly excluded.

Vanguard is the only one to my knowledge that does not allow any non-owner/non-spouse employees it is specifically in there in B&W in their adoption agreement. Eligibility "There will be no age and service requirements under this Plan"

Except for Form 5500-EZ reporting and no anti-discrimination testing a one-participant 401k is virtually 100% just like any other 401k plan including employee eligibility requirements.

[litovskyassetmanagement]

spiritrider wrote:

Kon Litovsky wrote:

Fidelity is very clear that you should not have non-partner/non-spouse employees, and so is Vanguard, I haven’t checked others, but I’m sure that’s the case as well. That’s what makes it a ‘solo’ 401k.  The employees they are talking about are spouses and/or partners if they are getting a W2.

Click to expand…

Sorry Kon, why can’t you just admit you are plain wrong on this.

Fidelity is very clear that you can not have non-owner/non-spouse participants. They are very clear that you can restrict employee eligibility through their adoption agreement fully in compliance with the IRC and IRS regulations. Did you even bother to actually read the adoption agreements in the links I provided. If you had you would see they specifically allow such restrictions. Clearly they are talking about employees other than spouses, because that would be totally unnecessary.

This has been verified over the years with extremely knowledgeable and experienced TPAs. If all you are doing is talking to CSR’s you are getting incorrect information. I and dozens others I know have had excludable employees for up to a decade or more. Someone even has had a plan audit in that time (trigger unrelated to eligible employees). On this issue all they were required to provide was employment and payroll records to verify no eligible employees ever existed.

Vanguard is the only one to my knowledge that does not allow any non-owner/non-spouse employees it is specifically in there in B&W in their adoption agreement. Eligibility “There will be no age and service requirements under this Plan”

Except for Form 5500-EZ reporting and no anti-discrimination testing a one-participant 401k is virtually 100% just like any other 401k plan including employee eligibility requirements.

Click to expand...

Yes, technically a solo 401k can be just like any 401k with the right plan doc, but the plan doc that all of these brokerages provide has many provisions that are not going to work for most plans with employees.  While you can use this plan doc for a plan with employees, there is a reason why Fidelity says that this is not to be used for a plan with employees, though with their adoption agreement they do allow you to add employees to the plan since they can't possibly discriminate against employees if you hire them.  That's why it is such a confusing thing for many solo practice owners who don't understand the difference between a solo 401k and a 401k with a customized plan document.  In order to have a plan document that is going to work for a specific practice, it would take a lot of amending with a typical solo 401k plan document that nobody is going to be doing, that's for sure.  So it is always better to avoid starting a solo 401k plan if you already HAVE employees, regardless of whether a plan document allows for them or not.  Just because something is technically possible does not make it a good thing to do.

[jsx30]

Drdds- Do you have any follow up from your original post? My wife is in the same situation. 2 employees but non will get close to 1000 hours. I have talked with Employee Fiduciary and they said that a solo 401k was ok. They also seemed to think that it would not be a problem to amend the solo 401k in the future if her employees became eligible. Do you or anybody else here have any experience changing a solo 401k plan to a regular type 401k? Thanks!

[The White Coat Investor]

spiritrider wrote:

Kon, this is not a generic limitation of one-participant 401k plans.

Vanguard’s Individual 401k plan does not allow the election of employee eligibility restrictions in their adoption agreement. This is relatively unique and one of the reasons I do not recommend their plan. They also do not allow rollover contributions or their Admiral Shares.

However, this is not true of many other one-participant 401k plans. Fidelity, Schwab, TD Ameritrade, ETrade, etc… allow the election of employee eligibility restrictions in their adoption agreements/plans.

Click to expand...

They allow admiral shares now although they did not when you wrote the post.

[litovskyassetmanagement]

jsx30 wrote:

Drdds- Do you have any follow up from your original post? My wife is in the same situation. 2 employees but non will get close to 1000 hours. I have talked with Employee Fiduciary and they said that a solo 401k was ok. They also seemed to think that it would not be a problem to amend the solo 401k in the future if her employees became eligible. Do you or anybody else here have any experience changing a solo 401k plan to a regular type 401k? Thanks!

Click to expand...

Please don't take plan level advice from EF, they are not qualified to offer such advice given that you are not talking to an actual TPA.

Here's a comment from an actual TPA:

"I did a webinar about recent developments in Congress and one of the bills expected to pass is that they are going to change the law to make it a requirement to include long time part timers even if they don't ever work 1000 hours, after 3 years of employment. But in the meantime people are not understanding that in the eyes of the IRS, there is no such thing as a solo 401k plan. The document has to have the same language as a "regular" plan doc, but of the choices available in a prototype, the "solo" is usually more liberal with respect to eligibility to join the plan, eligibility for contributions, etc. So they just might be shooting themselves in the foot with that approach - the "solo" doc might be so liberal it will let the part timers in immediately."

What about amending the plan doc when employees become eligible?

TPA: "You can't retroactively amend the doc once somebody met the eligibility requirements. It is anti cutback rules. You cannot take away a benefit right or feature that somebody has already earned."

My take on this is that if you have non-spouse employees, don't play the 'solo' game, it is definitely not worth it.  Get an illustration assuming they are eligible, and set up an appropriate 401k plan.  You don't need to include them in the plan, but as soon as one of them works 1000 hours the plan has to accommodate them because even if they drop below 1000 hours they still remain eligible.  With your own plan doc you can have full control over plan provisions, and you can select the ones that work best for you (such as having the longest eligibility waiting period, 6 year vesting for profit sharing, in-plan Roth rollover, etc, etc).

It is can still be worth doing a 401k plan even if you are giving money to the staff because it is better than giving money to the government.  If the employer contribution cost is too high, you can do a SIMPLE IRA, or just do a Safe Harbor 401k without any profit sharing.

[jsx30]

Kon Litovsky wrote:

jsx30 wrote:

Drdds- Do you have any follow up from your original post? My wife is in the same situation. 2 employees but non will get close to 1000 hours. I have talked with Employee Fiduciary and they said that a solo 401k was ok. They also seemed to think that it would not be a problem to amend the solo 401k in the future if her employees became eligible. Do you or anybody else here have any experience changing a solo 401k plan to a regular type 401k? Thanks!

Click to expand…

Please don’t take plan level advice from EF, they are not qualified to offer such advice given that you are not talking to an actual TPA.

Here’s a comment from an actual TPA:

“I did a webinar about recent developments in Congress and one of the bills expected to pass is that they are going to change the law to make it a requirement to include long time part timers even if they don’t ever work 1000 hours, after 3 years of employment. But in the meantime people are not understanding that in the eyes of the IRS, there is no such thing as a solo 401k plan. The document has to have the same language as a “regular” plan doc, but of the choices available in a prototype, the “solo” is usually more liberal with respect to eligibility to join the plan, eligibility for contributions, etc. So they just might be shooting themselves in the foot with that approach – the “solo” doc might be so liberal it will let the part timers in immediately.”

What about amending the plan doc when employees become eligible?

TPA: “You can’t retroactively amend the doc once somebody met the eligibility requirements. It is anti cutback rules. You cannot take away a benefit right or feature that somebody has already earned.”

My take on this is that if you have non-spouse employees, don’t play the ‘solo’ game, it is definitely not worth it.  Get an illustration assuming they are eligible, and set up an appropriate 401k plan.  You don’t need to include them in the plan, but as soon as one of them works 1000 hours the plan has to accommodate them because even if they drop below 1000 hours they still remain eligible.  With your own plan doc you can have full control over plan provisions, and you can select the ones that work best for you (such as having the longest eligibility waiting period, 6 year vesting for profit sharing, in-plan Roth rollover, etc, etc).

It is can still be worth doing a 401k plan even if you are giving money to the staff because it is better than giving money to the government.  If the employer contribution cost is too high, you can do a SIMPLE IRA, or just do a Safe Harbor 401k without any profit sharing.

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Ok, I understand what you are saying. I don't think she has a problem setting up a 401k plan that would eventually include employees who become eligible. That's what I meant when I ask the question about amending her solo 401k. I meant to ask if she could amend the plan to become inclusive of eligible employees. I don't really care if the IRS sees the plan as a solo 401k or a traditional. My reasons for making the delineation is that the plans make the delineation by charging much more for a non "solo" 401k. At EF its a difference of 2600 dollars as a startup fee and 1300/year after the initial. I don't see why we wouldn't go with the "solo" option if it saves us fees and can be changed in the future to include eligible employees.

Even if the above bill gets passed any time soon (and I have little faith that congress can agree on anything these days) it would be 3 years after that before she would have an eligible employee under her current arrangement. My guess is that from this point with a nebulous bill that might or might not get passed, she's 4-5 years from having an eligible employee. Also, I would guess the chance for employee turnover is unfortunately high for a receptionist so it may even be longer. At 4 years, that's 6500 in fees that is the difference between setting up a "solo" vs. regular 401k.

As far as actual plans go, I'm trying to find a reason why we shouldn't set her up with a 401k plan under the solo name while keeping in mind that someday (sooner or later) she would have an employee or two that will become eligible to participate.

 

 

 

[litovskyassetmanagement]

jsx30 wrote:

Kon Litovsky wrote:

jsx30 wrote:

Drdds- Do you have any follow up from your original post? My wife is in the same situation. 2 employees but non will get close to 1000 hours. I have talked with Employee Fiduciary and they said that a solo 401k was ok. They also seemed to think that it would not be a problem to amend the solo 401k in the future if her employees became eligible. Do you or anybody else here have any experience changing a solo 401k plan to a regular type 401k? Thanks!

Click to expand…

Please don’t take plan level advice from EF, they are not qualified to offer such advice given that you are not talking to an actual TPA.

Here’s a comment from an actual TPA:

“I did a webinar about recent developments in Congress and one of the bills expected to pass is that they are going to change the law to make it a requirement to include long time part timers even if they don’t ever work 1000 hours, after 3 years of employment. But in the meantime people are not understanding that in the eyes of the IRS, there is no such thing as a solo 401k plan. The document has to have the same language as a “regular” plan doc, but of the choices available in a prototype, the “solo” is usually more liberal with respect to eligibility to join the plan, eligibility for contributions, etc. So they just might be shooting themselves in the foot with that approach – the “solo” doc might be so liberal it will let the part timers in immediately.”

What about amending the plan doc when employees become eligible?

TPA: “You can’t retroactively amend the doc once somebody met the eligibility requirements. It is anti cutback rules. You cannot take away a benefit right or feature that somebody has already earned.”

My take on this is that if you have non-spouse employees, don’t play the ‘solo’ game, it is definitely not worth it.  Get an illustration assuming they are eligible, and set up an appropriate 401k plan.  You don’t need to include them in the plan, but as soon as one of them works 1000 hours the plan has to accommodate them because even if they drop below 1000 hours they still remain eligible.  With your own plan doc you can have full control over plan provisions, and you can select the ones that work best for you (such as having the longest eligibility waiting period, 6 year vesting for profit sharing, in-plan Roth rollover, etc, etc).

It is can still be worth doing a 401k plan even if you are giving money to the staff because it is better than giving money to the government.  If the employer contribution cost is too high, you can do a SIMPLE IRA, or just do a Safe Harbor 401k without any profit sharing.

Click to expand…

Ok, I understand what you are saying. I don’t think she has a problem setting up a 401k plan that would eventually include employees who become eligible. That’s what I meant when I ask the question about amending her solo 401k. I meant to ask if she could amend the plan to become inclusive of eligible employees. I don’t really care if the IRS sees the plan as a solo 401k or a traditional. My reasons for making the delineation is that the plans make the delineation by charging much more for a non “solo” 401k. At EF its a difference of 2600 dollars as a startup fee and 1300/year after the initial. I don’t see why we wouldn’t go with the “solo” option if it saves us fees and can be changed in the future to include eligible employees.

Even if the above bill gets passed any time soon (and I have little faith that congress can agree on anything these days) it would be 3 years after that before she would have an eligible employee under her current arrangement. My guess is that from this point with a nebulous bill that might or might not get passed, she’s 4-5 years from having an eligible employee. Also, I would guess the chance for employee turnover is unfortunately high for a receptionist so it may even be longer. At 4 years, that’s 6500 in fees that is the difference between setting up a “solo” vs. regular 401k.

As far as actual plans go, I’m trying to find a reason why we shouldn’t set her up with a 401k plan under the solo name while keeping in mind that someday (sooner or later) she would have an employee or two that will become eligible to participate.

 

 

 

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The problem with solo 401k is that once employees become eligible, the less beneficial provisions are in place (vs. what you can do with a custom plan document), and you can't take away the benefit from the employees, that's why it is not a good idea. You can't amend the plan to take away benefits from eligible employees.  So if you set up your own plan you have the option to give them less benefits than a typical solo 401k plan doc might include.  So you might want to spend some time to read the plan docs and understand what is included, and what happens when employees become eligible.  And the best thing to do is hire a Third Party Administrator to get you a custom plan document (vs. using Vanguard/Fidelity/Schwab, etc.).  With a custom plan document you have the option of including all of the best provisions so that when they do become eligible, then you'll be ready. And you don't have to set up a participant-directed 401k plan with EF, as that's the only thing they can do.  Pooled is just fine, and you can select a custodian for the pooled account.

Since when is EF charging $2600 startup fee?  I've never heard of that one. However, the cost of benefits given to staff who are eligible can potentially be higher than that.  This is why it helps working with a TPA, not EF.